On Eve Of The Internet Radio Fairness Act Hearings

(UPDATE 3) With Congressional hearings set for Wed. 11/28, David Macias, president of Nashville based label services company Thirty Tigers, shares his views on The Internet Radio Fairness Act.

Somewhere up in heaven, Rube Goldberg is looking down,
thrilled with the method by which owners of recording and publishing copyrights
are paid for their use in the US (for those of you in the UK that want to follow
along, substitute Heath Robinson for Rube Goldberg). If a song is played on
terrestrial radio for a recording that I own, that radio station pays nothing
for its use, so the percentage of revenues terrestrial radio pays for the use
of that recording is, let’s say it together, ZERO. Now let us look at what
Pandora pays for the use of recordings. It’s estimated that they paid $136M [1] to Sound
Exchange for the use of recordings on gross revenues of $274m. As a percentage
of revenues, Pandora is paying 50 PERCENT.

On the other hand, let’s look at what owners of publishing
copyrights and songwriters get paid from terrestrial radio and Pandora.
According to a recent article in Digital Music News [2], an
unnamed executive claims Pandora pays to publishers less than 10% of what they
pay out to owners of recordings. Let’s assume for the sake of easy math that it
is 10%. That means that Pandora pays out approximately $15m in royalties to PROs
(performing rights organizations) on behalf of owners or publishing copyrights
and songwriters.

click on chart to enlarge
ASCAP and BMI collected revenues of $1.75b in 2011, and adding
in revenues from SESAC (a private concern that does not divulge information
about revenues), let us call it an even $2b. According to a 2005 paper by
Harvey Reid [3],
35% of PRO revenues come from terrestrial radio; therefore we can estimate that
$700m is collected by the PROs on behalf of owners or publishing copyrights and
songwriters.

According to a Business Insider article from 2011 [4], Pandora
accounted for 4% of total US radio hours (and that number is climbing). If you
extrapolate what Pandora would pay if they paid the same rate as terrestrial
radio, assuming that they were the same size, they would have paid $375m for
what terrestrial radio paid $700m for.

TO RECAP:Pandora pays far less to owners of publishing
copyrights than terrestrial radio, and pays far more to owners of recording
copyrights. And satellite radio pays rates on a different scale altogether.

The
result of this confusing mish mash of royalty rates is that artists and
songwriters often cannot keep tabs on how much money they should be earning
from various mediums. Another outcome is that organizations that act as
advocates for these constituencies use data selectively to lobby for the narrow interests of their clients, rather than try to look
holistically at what will allow each link on the value chain to earn fair value
for the contributions.

Some examples:

The heads of the National Music Publishers' Association,
Nashville Songwriters Association International and the Church Music Publishers
Association recently released a joint statement to Congress that said in part,
"Put another way, for every dollar paid in music royalties by Internet
radio, only 8 cents of it is going to songwriters and publishers, while 92
cents is paid to record labels and artists through SoundExchange," they
wrote. "This disparity is not defensible." [5]

Were the gentlemen that run those organizations as outraged
by the fact that their membership receives 100% of the benefits for terrestrial
radio play, while record labels receive none? I haven’t seen the entire
statement, but my guess is that they probably neglected to mention that particular
indefensible disparity.

On the other hand, Pandora founder Tim Westergren has been
arguing for a royalty rate that equals 8% of revenues, essentially asking for
the same percentage of revenues that SiriusXM pays for music. That rate would
set a dangerous precedent for the recording industry and artist community,
setting off what Rep. Jerrold Nadler has correctly termed “a race to the
bottom” in terms of compensating the creative community for the use of their
works. That 8% rate was set at a time when Sirius and XM were two separate
companies, struggling for financial viability. That is no longer the case. It
is time to revisit that rate, while we’re on the subject. One suspects that
Mr.Westergren has done the math and understands the devastating effect that an
8% rate would have on the recording community.

I also find a couple of the bill’s points a little
disingenuous. For those that have not read them, here are the five points the
Copyright Royalty Judges will need to consider in addition to what is already
listed as the criteria for setting royalty rates in the 801(b) section of the
Copyright Act:

not disfavor rates that
are set based on a percentage of the online service’s revenue,

establish a fee
structure that encourages competition among copyright owners and between
online radio and other services,

consider the promotional
value of online radio,

consider the value
online radio gives to the value of the works it streams, and

not consider interactive
license fees or prior CRJ rates.

Points
1, 2 and 5 seem reasonable enough. There are plenty of businesses that pay a
specific percentage of their revenues for the right to use or license
intellectual property. The US economy is best served by not giving competitive
advantages to one segment of an industry over another, something that is
clearly happening under the current royalty regime. And comparing rates that
non-interactive streaming sites pay to those paid by on demand interactive
sites seems obvious enough.

However,
points 3 and 4 seem incredibly self-serving and could reinforce a dangerous
precedent. Terrestrial radio has justified using, royalty free, the recordings
owned by artists and labels for years with the same argument. It’s especially
specious when it comes to Pandora. Artists and labels have no control over why
and when their music is selected to be played. Unlike terrestrial radio or satellite
radio, the industry cannot “promote” through Pandora, which frankly, is one of
the reasons consumers probably like it so much. But to disallow any path to
promote while simultaneously touting the promotional value is, well,
disingenuous.

The Critics Fight Back

Critics of the recently proposed Internet Radio Fairness Act
(IRFA) that Pandora has been lobbying so hard for have started fighting back.
An ad ran in Billboard that was signed by a slew of artists asking why Congress
is considering cutting the royalties that artists depend on. Ben Sisario of The
New York Times wrote in a recent article that there is a widespread belief (a
belief I have heard espoused personally) that Pandora could climb out of
unprofitability, and lower that 50% number simply by selling more ads or
increasing the number of subscribers. Undoubtedly that is true. But as someone
who recently switched over from the ad supported side of Pandora to their
ad-free paid Pandora One service because I was tired of hearing so many ads, I
have sympathy for Pandora’s unwillingness to alter their ad mix to the possible
detriment of their business. Advertisers seem to be coming around to the value
of Pandora, however. 88% of Pandora revenues were from ads, and those revenues
have skyrocketed in the past two years ($55m in YE 1/31/2010 and $274m in YE
1/31/2012). Their listenership grew by 50% last year, while their revenues grew
by 100%. That would seem to indicate that, as listenership grows, revenues will
grow even faster, which makes sense. Even if the rates per stream don’t change,
other marginal costs per new listener should not be very much at all, as it the
case with almost all technology-based mediums. I’m also confident that more
people will opt, as I did, for the Pandora One service. People are gladly paying
over $150 for SiriusXM service, so it’s not a stretch to think that, with some salesmanship,
Pandora could grow from around 1m paid $36 subscriptions to 10m in the near
future (SiriusXM has 25m), which would generate $360m annually, with a decent
amount of revenue still to be garnered from advertising. Pandora will probably
grow their way into profits in the near future regardless of whether the rate
structure changes.

It has been speculated that the reason this has become such
a cause for them of late has to do with the company going public in June of
2011, and that their case will be viewed more sympathetically now, when they
are losing money, as opposed to the near future, when it is possible that they
won’t be. There is undoubtedly intense pressure from shareholders to right the
ship financially, but critics who mention this are wrong to use this as a
justification to dismiss their argument. What difference does their timing
matter, and why shouldn’t Pandora be able to pay a more reasonable rate to boost
profits? Although I think Westergren probably overstates his case, the current
rate structure is hard to justify, and Pandora has every right to compete without
one arm tied behind its back. I would imagine that Pandora’s attorneys have
looked at and rejected an argument that this violates the Clayton Act’s
strictures on price discrimination, but how one runs a business paying for
something that your competitor does not have to pay for would strike me as
grounds for an argument of this sort.

I think it’s also possible that the music business could be
doing itself a favor by agreeing to a lower fixed percentage of revenues, say
25%, if Pandora would agree to that. Pandora’s revenues for the first two
quarters of 2011 were $118K; the first two quarters of this year were $182K.
Revenues grew by 100% the previous year, and it is on pace to grow another 54%
this year. Assuming that revenue growth tapers off over time, but they continue
adding 10m subscribers annually, revenues from 25% of gross revenues will outpace
revenues from the current royalty system by 2016 and pay more total revenues
through 2020 (see table).

One would also hope that it would give moral authority to Congress
to finally allow passage of a law allowing the collection of performance
royalties from terrestrial radio stations (currently a much bigger piece of the
radio pie). If terrestrial radio were able to pay just 1% of revenues in
royalties to the owners of recordings, it would mean an additional $100m in
revenues paid, at least according to proposal offered by the NAB to start
paying performance royalties to owners of recording copyrights. That would more
than make up for the loss in revenues that would come from moving Pandora from
paying 50% of their gross revenues to 25%. That 1% rate seems too low to me,
but I also recognize that terrestrial radio has built its business without
having to pay these royalties (thank goodness that they seem to have dropped
that nonsense about calling it a tax). A 1% royalty is a good place to start,
as long as it can go up slightly over time, thus letting terrestrial radio financially
adjust to the brave new world of performance royalties.

Of course, a similar reimagining of the pie would have to
occur on the publishing side as well.

If Pandora gets its way in paying 8% of gross revenues, the
owners of recording copyrights will be underpaid for their work. If some
version of the IRFA does not pass, then we will be asking internet based radio
entities to conduct business in an unfair environment that impairs their
ability to compete and possibly even survive. If the IRFA passes without ALSO
passing legislation mandating the payment of performance royalties by
terrestrial radio stations, then it will have a devastating impact on the
recording industry and its artists. If Mr. Westergren wants the music
community’s support, perhaps he should call on Congress to finally rectify the
wrong of the US being one of the only countries on earth that does not mandate
the payment of performance royalties by terrestrial radio stations to owners of
recordings. These two issues should absolutely be linked.

It is time to end the jury-rigged method of royalty payments
that leaves the entire music creator community utterly confused about revenue
streams due them, but it is also high time that all the players involved stop
foisting one-sided viewpoints into the arena.
A sensible approach that allows artists, songwriters, labels and
broadcasters to earn their fair share can be crafted if we put our minds to it.
I encourage the members of the House Judiciary Subcommittee on Intellectual
Property, Competition, and the Internet to discuss the NAB’s previous offer to
finally start paying a small performance royalty as a part of an equitable
solution.

Hi Dave-When discussing the 801(b) section of the Copyright Act, you completely reject points 3&4, the idea that radio spins are promotional. If you are right, why do record labels still have promotions departments whose job it is to send promotional copies of the records they want to promote to radio stations? Some labels and bands hire third parties called radio promotion companies to send those promotional copies to radio. Those radio promo companies then follow up with Music Directors and DJs to encourage them to play these records.

Why would labels/artists go to such lengths to push radio to play their music if radio spins are not promotional?

I don't completely reject the notion that radio spins are promotional, but I am very cautious about the precedent that they should in way be used to lower the rates that should be paid to owners of recordings. It's the same principle as saying that it's okay for people to download music for free without the permission of the artist, well, because, you know, people might go to shows and concerts. What I reject is the justification of using someone's work for commercial gain and not compensating them through that aforementioned justification.

My point about Pandora is that you can't even promote through them. At least with a more traditional radio station, there's some give and take that allows promotion. On Pandora, you have to hope that the algorithm leads people to your music.

Spotify, Pandora et al are all desperately trying to pay regular radio play fees as opposed to profit sapping royalties which leave them all valued at billions on paper yet struggling to post profits. Should the Internet Radio Fairness act fail to become law the arena will continue to become overcrowded as perhaps the largest loss leader on the internet.

But what is the hidden story that remains for the most part untold; YouTube music.

YouTube music has not only settled all major issues with the big labels to their mutual advantage but has opened up their API to enable startups like http://www.fuhshnizzle.com to offer superior services that integrate the best of Pandora, Rhapsody, Playlist.com, etc. without commercial interruption or registration.

They are all missing the boat in that the web is a multimedia environment rather than the auditory only sphere of radio. IMHO of course.

Sadly I think the bottom is going to need to fall out on the music content "space" before any changes are made toward a sustainable business model. The content creators seem to overvalue their work (or just want to extract as much $ as possible before the inevitable market changes occur) while consumers seem to think the content is worth (in what they are willing to pay) less and less. The Pandoras and the Spotifys of the world are trying to meet somewhere in the middle in which the content creators are seeing $, consumers are opening their wallets because the price is right, but these companies can also be profitable which allows then to continue to grow which just generates more money for the content creators

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